The present invention is directed to a system, method and financial product that enable individuals, especially those who are entering or are in retirement, to ensure future income with a reduced financial outlay. The present invention can be implemented by insurance companies and other financial institutions.
As individuals approach and enter into retirement, their financial profiles change due to the absence of wage income. With the decline in defined benefit pension plans over the past few decades and the modest income benefits and uncertainty of Social Security, most of these individuals will rely primarily on accumulated savings as a means of supporting their future lifestyle needs. Thus, individuals have fixed and limited resources that must fulfill their financial needs for the remainder of their lifetimes.
Recognizing the trend toward longer life expectancies, life insurance companies have historically positioned immediate annuities as a primary source of income protection. This requires individuals to “annuitize,” or convert a portion of their savings into a lifetime income stream. FIGS. 1-4 illustrate the basic anatomy of a conventional retirement plan/annuity approach for converting defined contribution savings into lifetime income streams to protect against outliving assets.
While annuitization is an effective way of budgeting a limited amount of savings for retirement (and avoiding investment return risks (see FIG. 2), investment return timing risks (see FIG. 3), and longevity risks (see FIG. 4)), individuals and financial advisors have shied away from these traditional products, including for the following reasons: (i) they are expensive and laden with many fees and unnecessary features, (ii) they are illiquid, and (iii) a substantial economic loss results if the beneficiary dies soon after purchasing the annuity.
The concentration of wealth within the so-called “Baby Boomer” demographic has fueled the creation of new products and services that can more effectively meet the needs and preferences of this demographic. More recent products have presented alternative forms of income protection. However, such products also have their disadvantages.
For example, life insurance companies have introduced guaranteed minimum withdrawal benefits (“GMWB”) on deferred annuity contracts, which guarantee that an individual can redeem a specified amount of annual income from their deferred annuity contract regardless of the current account value. While this feature helps to overcome the liquidity and estate issues of immediate annuities, this solution has its shortcomings. Deferred annuity contracts tend to have higher fees than other accumulations vehicles, and, as a result, are generally not viewed favorably within the financial planning community. Additionally, the ability to invest the account balance of a deferred annuity is restricted to a series of mutual funds offered within the product. Also, over the long term, the cost of the GMWB relative to the benefit received will be greater than the corresponding cost of an immediate annuity.
Accordingly, a need exists for an alternative to conventional annuitization that provides income protection at reduced cost. The system, method and financial product according to the present invention provide such an alternative.